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Arbor Realty Trust, Inc. (NYSE:ABR)

Q1 2009 Earnings Call Transcript

May 8, 2009 10:00 am ET

Executives

Paul Elenio – Chief Financial Officer

Ivan Kaufman – President and Chief Executive Officer

Gene Kilgore – Senior Vice President, Structured Securitization

Analysts

David Fick – Stifel Nicolaus & Co.

David Chiaverini – BMO Capital Markets

Operator

There are no further questions in the queue.

Presentation

Operator

Good day, ladies and gentlemen, and welcome to the first quarter 2009 Arbor Realty Trust earnings conference call. (Operator instructions) As a reminder, this conference is being recorded for replay purposes. I will now like to turn the presentation over to your host for today’s call, Mr. Paul Elenio, Chief Financial Officer.

Paul Elenio

Good morning everyone and welcome to the quarterly earnings call for Arbor Realty Trust. This morning we’ll discuss the results for the quarter ended March 31, 2009. With me on the call today is Ivan Kaufman, our President and Chief Executive Officer.

Before we begin, I need to inform you that statements made in this earnings call may be deemed forward-looking statements that are subject to risk and uncertainties including information about possible or assumed future results of our business, financial condition, liquidity, results of operations, plans, and objectives. These statements are based on our beliefs, assumptions, and expectations of our future performance, taking into account the information currently available to us. Factors that could cause actual results to differ materially from Arbor’s expectations in these forward-looking statements are detailed in our SEC reports. Listeners are cautioned not to place undue reliance on these forward-looking statements, which speak only as of today. Arbor undertakes no obligation to publicly update or revise these forward-looking statements to reflect events or circumstances after today, or the occurrences of unanticipated events. I will now turn the call over to Arbor’s President and CEO, Ivan Kaufman.

Ivan Kaufman

Thanks to everyone for joining us on today's call. Before Paul takes you through the financial results for the quarter, I would like to spend some time talking about our view of the market and the strategy and approach we are taking during these extremely difficult times.

As we discussed on our last few calls, the market remains severely dislocated and significant liquidity issues continue to weigh heavily on the financial sector. These are unprecedented times and companies in our space continually face significant challenges as the real estate market continues to worsen and there are no signs of available liquidity.

We believe there will be increases in delinquencies and defaults and continued declining real estate values through 2009. No one is immune to the effects of this market and this will likely result in additional losses throughout our sector. We will continue to operate our business in the best possible way to successfully navigate through this extremely difficult environment. Our total focus continues to be to retain and preserve as much liquidity as possible and aggressively mange our portfolio and financing sources.

We have worked extremely hard at improving our operating cash balance since year end and are pleased with our results but are constantly working on new strategies to improve our liquidity. Currently we have around $18.0 million in operating cash and around $33.0 million in cash posted against our swaps, which as I mentioned last quarter, was temporary and will come back to us my maturity of these swaps.

We also have $22.0 million in cash available in our CDOs after fully deploying the cash in CDO-1 in April prior to the end of that replenishment period. Clearly, preserving and maximizing liquidity is critical to successfully managing through this significant downturn.

We are very pleased with the completion of our trust preferred securities restructuring and project that the reduced fixed rate of 50 basis points will result in approximately $25.0 million of cash savings over the three-year modification period.

We also continue to improve our liquidity by working aggressively with our borrowers to repay their loans. In the first quarter we generated $50.0 million of runoff and also refinanced and modified $160.0 million of loans.

It is difficult to accurately predict repayments in this environment and our previous guidance was in a range of around $50.0 million to $100.0 million of runoff per quarter. Based on the current market conditions, we are revising the guidance to a range of around $25.0 million to $50.0 million of runoff a quarter going forward.

We continue to manage our funding sources aggressively, which is also critical in this environment. We have been very focused on reducing our exposure to short-term debt by delivering our balance sheet for runoff and proactively moving assets into our CDO vehicles. We reduced our short-term debt by $33.0 million during the first quarter and by another $45.0 million already in the second quarter.

Additionally, as I mentioned earlier, we were successful in modifying our trust preferred securities. We currently have around $445.0 million of short-term debt, $375.0 million is with one financial institution that we are currently spending a significant amount of time working to potentially modify and extend.

We were also successful in taking advantage of the dislocated market in the first quarter by repurchasing $33.0 million of our own debt at a substantial discount, recording a $26.0 million gain and improving cash flow going forward by reducing debt service payments. We will continue to evaluate similar transactions in the future, based on availability, pricing and liquidity.

Additionally, we are very pleased to have closed a Prime transaction during the first quarter generating a $37.0 million tax deferred gain and adding $1.50 to book value per share, which on an adjusted basis was around $17.00 at March 31, 2009.

As we said before, these equity kickers are a key part of our business model and we have generated significant cash flow and earnings from the monetization of these investments to date.

Now I will spend some time updating you on our credit and asset management efforts. As you can see from our press release, we recorded $67.5 million of loan loss reserves during the first quarter. These reserves were related to 14 loans with an outstanding balance of approximately $438.0 million. We now have $198.0 million in loan loss reserves related to 18 assets with an outstanding balance totaling approximately $580.0 million as of March 31, 2009.

I would like to point out that $30.0 million of the first quarter reserves is due to a significant event in which two of our loans were included in an overall bankruptcy by a borrower. Based on these new facts we felt it was prudent to significantly reserve against these investments. Another $12.0 million of reserves were related to assets we had recorded reserves on in the past, with the remaining $25.5 million of reserves relating to other loans in our portfolio.

These reserves were based on detailed quarterly review of the portfolio, which takes into account the value and operating and operating status of these properties and reflects the continued market downturn.

These market conditions have also increased defaults and delinquencies in our portfolio, resulting in approximately $285.0 million of non-performing loans, up from $135.0 million last quarter. As Paul will explain later, this has also reduced the net interest spread on our portfolio.

As we have said many times, no one is immune to the effects of this market and we will continue to operate our business expecting and preparing for the worst. With borrowers' access to liquidity almost nonexistent and further expected declining real estate values, we believe we will see ongoing stress on our portfolio and additional defaults and delinquencies.

This will likely result in additional future losses but predicting the amount and timing will be very difficult. We are fortunate to have a very seasoned and talented asset management team, which is a critical component during these times.

We remain extremely focused on managing our portfolio, looking to minimize losses and monetize as many assets as we can, creating precious liquidity and resolving any and all issues as quickly as possible.

In summary, these are unprecedented times and we are operating in an extremely difficult environment. We have worked exceedingly hard and I believe our management team has the expertise and discipline to face the significant challenges ahead of us.

We will stick to our core objectives, focusing heavily on liquidity, capital retention, and the aggressive management of our portfolio and short-term borrowings. Success in these critical areas is vital for us to manage through the cycle.

I will now turn the call over to Paul to take you through some of the financial results.

Paul Elenio

As noted in the press release, we had a loss for the first quarter of $0.17 per share and an FFO loss of $0.15 per share. As Ivan mentioned, there were several large items that affected the first quarter numbers.

We recorded $67.5 million of loan loss reserves and $9.0 million in losses on certain assets in our portfolio during the quarter. We now have $198.0 million of loan loss reserves on 18 loans with an unpaid principal balance of around $589.0 million at March 31, 2009.

Clearly, no one is immune to the effects of this market and we will continue to take a proactive approach in evaluating our portfolio, recording reserves where we think it's appropriate, and remain aggressive in managing and monetizing our assets.

We were successful during the quarter at buying back some of our CDO and trust preferred debt at significant discounts, recording gains of approximately $26.0 million. As Ivan mentioned, as part of an ongoing strategy we will look to selectively repurchase debt at discounts with the timing of these purchases depending on several factors, including availability, pricing, and liquidity needs.

As noted in the press release, we also closed a Prime transaction that was previously disclosed, which resulted in a $37.0 million net gain for the first quarter. Undoubtedly, our equity kickers have been a key component of our business model and the monetization of these investments has contributed greatly to our earnings, liquidity, and capital base.

In addition, the first quarter included a $750,000 increase in interest expense for a change in the market value of certain interest rate swaps which GAAP requires us to flow through earnings, as compared to a $4.2 million decrease in interest expense in the fourth quarter. These swaps effectively swap out assets in our CDOs which pay based on one-month LIBOR and our CDO debt which is based on three-month LIBOR.

The value of these swaps will eventually return to par at the maturity of the trades, but if the market outlook for rates and spreads continue to fluctuate greatly, these trades could produce significant changes in value, which would increase or decrease our earnings going forward.

We also recorded $2.5 million of income during the quarter from our equity interest in the Alpine Meadows Ski Resort. As we mentioned several times, this business is seasonal and is not part of our core operations and therefore there will be fluctuations in our earnings related to this investment as there are losses in the summer months and income in the winter months.

We are estimating that we will have a loss in the range of $750,000 to $1.0 million for the second quarter of 2009 but believe our share of the operations for the full year will be close to break even, including depreciation expense.

So our adjusted core EPS would have been around $0.38 per share for the first quarter compared to around $0.47 per share for the fourth quarter, adjusting for non-recurring items and loan loss reserves. This decrease was primarily due to an increase in our non-performing loans during the first quarter, which as Ivan mentioned, reduced our overall net interest spread.

I will now take you through the rest of the results for the quarter. Our average balance in core investments declined about $65.0 million from last quarter, mainly due to runoff and pay downs in the first quarter. The yield for the quarter on these core investments was around 5.12% compared to 7.08% for the prior quarter.

Without some non-recurring items related to non-performing and restructured loans, as well as the acceleration of fees, the yield on these core assets was around 5.90% for the first quarter and around 7% for the fourth quarter. This decrease was primarily due to, as Ivan mentioned, an increase in the non-performing loans during the first quarter combined with a 200 basis point decline in the average LIBOR rate.

This was partially offset by fixed-rate loans and loans with LIBOR clause above the average LIBOR rate, representing approximately 75% of our portfolio.

Additionally, the weighted average all-in yield in our portfolio was around 5.82% at March 31, 2009, compared to 6.33% at December 31, 2008. This decrease was due to an increase in non-performing loans during the first quarter.

The average balance on our debt facilities decreased by around $86.0 million from last quarter, which was more than the decrease in our core investments. This was primarily due to our continued focus on reducing our exposure to short-term debt by moving loans out of our warehouse and term debt facilities into our CDO vehicles.

The average cost of funds in our debt facility was approximately 3.94% for the first quarter compared to 4.10% for the fourth quarter. Excluding the unusual impact on interest expense from our swaps, that I explained earlier, our average cost of funds was approximately 3.78% for the first quarter compared to around 4.94% for the fourth quarter. This reduction was primarily due to the decline in the average LIBOR rate during the quarter.

In addition, our estimated all-in debt cost was around 4% at March 31, 2009, compared to 3.80% at December 31, 2008.

So overall, normalized net interest spreads were relatively flat compared to the fourth quarter. This reflects the positive effect from the decline in the average LIBOR rate, offset by the increase in our non-performing loans.

As we said earlier, we are expecting additional defaults and delinquencies, which would reduce our net interest spreads going forward.

Next, our average leverage ratios were around 71% of our core assets and around 82% including the trust preferreds as debt for the first quarter, down from 72% and 84% for the fourth quarter. This reflects the continued delivering of our balance sheet for runoff and moving assets into our CDOs. Our overall leverage ratios on a spot basis were also down slightly to around 3.1 to 1 for the first quarter from 3.2 to 1 for the fourth quarter.

Turning quickly to our portfolio statistics as of March 31, 2009, about 65% of our portfolio was variable rate loans and 35% were fixed rate. For the product type, about 62% were bridge, 13% junior participation, and 25% mezzanine preferred equity. By asset class, 36% in multi-family, 26% is office, 17% hotel, 11% land, and 4% condo, all relatively unchanged from the prior quarter.

Our loan to value was around 85% and our weighted average million dollars outstanding was 60% and our portfolio had an average duration of around 30 months. Our debt service coverage ratio was around 139 this quarter and geographically we had around 40% of our portfolio concentrated in New York City.

Finally, as you may have seen in our proxy filing, we issued additional restricted stock grants of 245,000 shares on April 22, 2009, to certain of our employees, employees of our manger, and our non-management directors. These shares were immediately vested and we also accelerated all the approximately 326,000 shares of unvested restricted stock that was previously granted. These stock grants and accelerated vestings will result in a non-cash expense of approximately $2.0 million to our second quarter earnings but we will have no additional expense impact from these grants in the future.

That concludes our prepared remarks for today and we would be happy to answer any questions you may have at this time.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from David Fick – Stifel Nicolaus & Co.

David Fick – Stifel Nicolaus & Co.

Can you run us through how you're dealing with, or plan to deal with, the Wachovia term loan that comes up in 2010? Is that what you were referring to when you said you were talking to your lenders?

Ivan Kaufman

We're in negotiations with them. As you can see, that's primarily the only near-term debt that we have to deal with. We have a very good relationship with Wells Fargo and we are very optimistic that we will be able to come to a satisfactory restructuring of that debt, which will give us sufficient term in order to continue to operate this company very effectively without having to deal with liquidity issues.

David Fick – Stifel Nicolaus & Co.

Can you give us any detail on the credit line covenant breach issue?

Paul Elenio

On the one covenant that we breached as of March 31, it was the same covenant from year end. It's a liquidity covenant with one of our institutions that requires $15.0 million of cash and we were just under that with about $14.0 million this quarter. But since then we are now at about $18.0 million.

David Fick – Stifel Nicolaus & Co.

Can you review again the extended stay situation, where it stands? And since it's with your existing borrower on the Prime transaction, I'm just wondering if it's any cross play or collateralization that you might be able to asset there.

Ivan Kaufman

There is no cross play between Prime and ESH at all. ESH being the extended stay. I think that I'm a little limited on what I can say on the extended stay as we are in very serious and significant restructuring negotiations at the present time and it's a very sensitive matter at the moment.

Paul, do you have any comment on where we stand on that and further write downs?

Paul Elenio

As far as where we are with the investment that was remaining, you may remember we wrote it down to about $30.0 million at year end. In the first quarter we did receive about $12.0 million in cash out of that investment and we used that to pay down, as we talked about, going to a cost recovery method.

So currently our investment in ESH is down to $18.0 million from our book so we are real pleased with that and believe we will be able to collect that over time. But as far as any restructuring and negotiations, as Ivan mentioned, we are greatly limited on what we can say at this point.

Ivan Kaufman

All I would say, based on the last conversation we have, I would wait until the story is over before I write this one off. There's still some ample opportunities here for us to have an outcome that we may be able to talk about shortly.

David Fick – Stifel Nicolaus & Co.

And it's fair to say that you wouldn't have any additional funding or any claim against Arbor from any of the parties involved in this?

Ivan Kaufman

We couldn't really comment on that at the present time.

Operator

Your next question comes from David Chiaverini – BMO Capital Markets.

David Chiaverini – BMO Capital Markets

On the covenant breach issue, how much is outstanding with that financial institution?

Paul Elenio

That's the financial institution we were talking about, that's the significant amount of debt we have outstanding left, which is the Wachovia/Wells Fargo relationship.

David Chiaverini – BMO Capital Markets

Can you just remind me how much is outstanding on that?

Paul Elenio

It's about, all in with Wachovia/Wells Fargo, it's about $375.0 million outstanding. And we did receive the appropriate waivers, as we did at year end, for that covenant breach.

David Chiaverini – BMO Capital Markets

On this CDO-1, with the over collateralization test which you cured it, but I was just curious, how much interest income is derived from that CDO?

Paul Elenio

Off the top of my head, I don't know exactly how much waterfall distribution we get from that particular CDO. I have them in my head grouped together, but Gene Kilgore is on the line, who as you know, runs our securitization desk and I will ask and see if he has insight on that.

Gene Kilgore

I would say that it varies quarter to quarter, fairly significantly. I don't know if we disclose the number, quarter to quarter, but it does vary.

Ivan Kaufman

I believe the range is $4.0 million to $7.0 million out of that particular.

Gene Kilgore

It historically hasn't been less than about $4.0 million and it probably could go as high as $6.0 million or $7.0 million.

David Chiaverini – BMO Capital Markets

How did you go about curing it? Did you put more cash into it or did you add more collateral to it?

Gene Kilgore

Predominantly, we purchased—as you may be aware, that the tests are constructed based on par amount, not market value of an asset and as you might imagine most of the assets sold in the CDO today are at a discount so that has the effect of building par. And that primarily is the way that we cured the test.

Operator

There are no further questions in the queue.

Ivan Kaufman

We appreciate your attendance on today's call. As I went over in my comments, these are very difficult times. However, even with difficult times there are often opportunities and we are finding ourselves in the position now of really solidifying our position and developing a strategy within this market to operate somewhat effectively and we look forward the next quarterly call and any calls we get from you over the next couple of days.

Operator

This concludes today’s conference call.

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Source: Arbor Realty Trust, Inc. Q1 2009 Earnings Call Transcript
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